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FIN1FOF- Fundamentals of Finance
INDIVIDUAL ASSIGNMENT
Semester 1 2024
GUIDELINES
• This assignment requires students to prepare a detailed business report based on a case study by applying financial concepts such as capital structure, capital budgeting, and others in topics 1-7 in the course.
• This is an individual assignment marked out of 100 and contributes 25% of your overall assessment for FIN1FOF.
• Your report must be submitted via “Assignment Dropbox” on the FIN1FOF subject LMS site by 11:59 pm on Sunday 19th May, 2024. Hard copies will not be accepted. Make sure you have successfully attached your submission before submitting and exiting the Dropbox. Make sure you receive an email confirmation of your submission. If you aren’t sure, go back into Dropbox and check that your submission is attached.
Scenario
You work as a financial analyst in the Finance division of the Rural Services Ltd an Australian agribusiness company. Rural Services Ltd provides a range of products and services, across rural Australian towns, through a common distribution channel, including beef cattle feedlots, agricultural retail products, agency services, real estate services and financial services.
A deposit of lithium ore has been discovered recently on rural property owned by the company. Lithium is a critical element used in various applications, especially in the production of rechargeable batteries, which are used in a wide range of devices such as electric vehicles, smartphones, laptops, and energy storage systems. Additionally, lithium is also used in other industries, including aerospace, ceramics, glass, and pharmaceuticals.
The company is in the process of deciding whether or not to develop a mine on the property to extract the lithium to supply the rechargeable battery market in light of the increasing demand for rechargeable batteries. Your company’s Chief Financial Officer has asked you to make a recommendation as to whether or not the company should proceed with such a project, notwithstanding the significant diversification such an investment would represent for the company from itscore activities.
In order to analyse the financial viability of the project you obtain the 2023 Income Statement and Balance Sheet for Rural Services Ltd. Moreover, in order to analyse the risk and return of this project, which is so different from the current activities of Rural Services Ltd, you also obtain the 2023 Income Statement and Balance Sheet for Core Lithium Ltd, a small lithium miner listed on the ASX. These financial statements are provided on pages 4 and 5. You calculate some financial ratios to compare the financial performance of the two companies, which arepresented on page 6. You also collect some interest rate information, which is presented on page 7.
Rural Service Ltd
2023 Financial Accounts
INCOME STATEMENT million
Sales Revenue 1,000.0
Cost of Sales 800.0)
Gross Profit 200.0
Selling, General and Administrative Expenses (100.0)
EBITDA 100.0
Depreciation (50.0)
Interest Expense (7.5)
Pre-Tax Profit 42.5
Tax (12.8)
Net Profit 29.8
BALANCE SHEET million
ASSETS
Cash 10.0
Accounts Receivable 200.0
Inventory 150.0
Property Plant and Equipment 250.0
Total Assets 610.0
LIABILITIES
Accounts Payable 200.0
Bank Loan 25.0
Corporate Bonds 150.0
Total Liabilities 375.0
SHAREHOLDERS' EQUITY
Ordinary Shares 400.0
Retained Earnings (165.0)
Total Shareholders' Equity 235.0
Total Liabilities and Shareholders' Equity 610.0
Notes
1. The interest rate on the bank loan is 6.00% p.a.
2. The corporate bonds have a credit rating of BB and have 5 years to maturity. They make quarterly coupon payments at a coupon rate of 4% p.a.
3. The ordinary shares are shown on the balance sheet at their book value of $1 per share. They have abeta of 0.51. In 2023, they paid a dividend of $0.03 per share. The dividend is expected to grow at 5% p.a. for the next 3 years, after which it will grow at a constant 3% p.a. in perpetuity.
Core Lithium Ltd
2023 Financial Accounts
INCOME STATEMENT million
Sales Revenue 50.6
Cost of Sales (15.8)
Gross Profit 34.8
Interest Income 3.0
Selling, General and Administrative Expenses (21.0)
Other Non-operating Income/(Expense) (1.5)
EBITDA 15.4
Depreciation (3.9)
Interest Expense (2.3)
Pre-Tax Profit 9.2
Tax (1.6)
Net Profit 7.6
BALANCE SHEET million
ASSETS
Cash 152.8
Accounts Receivable 6.7
Inventory 28.9
Property Plant and Equipment 241.2
Other Assets 73.6
Total Assets 503.1
LIABILITIES
Accounts Payable 31.0
Bank Loan 83.6
Other Liabilities 33.6
Total Liabilities 148.2
SHAREHOLDERS' EQUITY
Ordinary Shares 370.9
Retained Earnings (16.0)
Total Shareholders' Equity 354.9
Total Liabilities and Shareholders' Equity 503.1
Interest Rates
Based on the current yields at which the 5-year and 10-year Government bonds are trading you assume that the 5-year risk-free rate is 3.974% and the 10-year risk-free rate is 4.315%.
The current corporate credit spreads areas presented in the table below.
Project Information
• You estimate the investment required to undertake the project will be equal to 20% of the Property Plant and Equipment (PPE) shown in the Core Lithium Ltd 2023 Balance Sheet (page 5).
• You are also aware that Rural Services Ltd has budgeted to spend $2 million in
professional, geotechnical and legal fees appraising the project before making its final decision.
• You estimate that the revenues in the first year of the project will equal the 2023
Revenue/Average PPE margin you have calculated for Core Lithium, shown on page 6, multiplied by the investment Rural Services will need to undertake the project.
• Further you are advised that the size of the resource is estimated to provide a five year life for the project and that revenues will grow by 35% in year 2, 25% in year 3, 15% in year 4 and 5% in its fifth and final year.
• You decide to be guided by the Cost of Sales/Revenue Ratio you have calculated for Core Lithium, as shown on page 6, which you will apply through the entire five year life of the project.
• Depreciation will be calculated using the diminishing value method with the aim of fully depreciating the investment by the end of the life of the project.
• You decide to apply the tax rate you calculated for Rural Services Ltd, shown on page 6.
• During the life of the project, you estimate that the firm will need to provide for an
annual increase in networking capital comprising an increase in Receivables and Stock, less an increase in Payables. You have calculated the Net Working Capital/Sales
Revenue Ratio of Rural Services Ltd and Core Lithium shown on page 6. You decide to
use the 2023 Net Working Capital/Sales Revenue Ratio of Rural Services Ltd to estimate the annual additional amount of Net Working Capital that will be required to service the Incremental Sales Revenue of the project, estimated each year.
• You also assume that in the year after the final year of the project’s life the firm will recover in full this net increase in working capital.
• In the year after the five year life of the project, you are advised that the company would need to spend $3 million in cleaning up the site and replanting.
• Your research also shows that the equity risk premium on the ASX is between 4 – 6%, so you decide to apply a 5% equity risk premium in your estimation of CAPM.
Tasks
You are required to complete the following tasks.
• Show the formula and complete calculations for each answer you calculate.
• Define all variables of each formula used and show any calculations required to adjust them for use in applying the formula to solving each problem.
• Format your answers as defined in each task.
• When incorporating an answer to a prior task in a subsequent task, use the value as it has been formatted. For example, if a task required you calculate and format as a percentage to 3 decimal places, the answer should be formatted as 1.234%. If this value is
subsequently included in the calculation of the answer to a subsequent task, then the value you must use is 1.234% or 0.01234.
Part 1: Calculate Rural Services Ltd’s Weighted Average Cost of Capital (30 marks)
a) Calculate the before-tax cost of Rural Services Ltd’s bank loans and corporate
bonds. Show your answer formatted as a percentage to 3 decimal places. (6 marks)
b) Calculate the cost of Rural Services Ltd’s ordinary shares. Show your answer formatted as
a percentage to 3 decimal places. (6 marks)
c) Calculate the estimated market value of Rural Services Ltd’s bank loans and
corporate bonds. Show your answer formatted as dollar values. (6 marks)
d) Calculate the estimated market value of Rural Services Ltd’s ordinary shares. Show your answer formatted as dollar values. (8 marks)
e) Calculate Rural Services Ltd’s WACC. Show your answer formatted as a percentage to four decimal places. (4 marks)
Please turnover for Part 2
Part 2: Estimate the project’s incremental free cash flows (30 marks)
a) Prepare the depreciation table for project’s investment in PPE, using the Diminishing Value
Method. Show your answer formatted as millions to 2 decimal places. (10 marks)
|
Year |
1 |
2 |
3 |
4 |
5 |
|
Opening Book Value |
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less Depreciation |
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Closing Book Value |
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b) Prepare the free cash flow table. Show your answer formatted as millions to 2
decimal places. (20 marks)
Please turnover for Parts 3 and 4
Part 3: Calculate the project’s NPV, IRR and Profitability Index (20 marks)
a) Calculate NPV of the project using the parameters you have estimated above. Show your answer formatted as millions to 2 decimal places. (4 marks)
b) Calculate the IRR of the project using the parameters you have estimated above and the
IRR function in Microsoft Excel. Show the parameters and values you incorporated in the IRR function as part of your answer. Show your answer as a percentage to 1 decimal place. (4 marks)
c) Calculate the Profitability Indexof the project using the parameters you have estimated above. Show your answer as a percentage showing no decimal places. (4 marks)
d) Should the project be accepted based on the assumptions and parameters you have used above? Explain your answer (8 marks).
Part 4: Review andrecalculate the project’s NPV, IRR and Profitability Index (20 marks)
a) Based on the analysis of the financial metrics you calculated on page 5 for Rural Services Ltd. and Core Lithium Ltd. What, if any, concerns might you have with the parameters you have used above to estimate the financial viability of the project? (5 marks)
b) If Rural Services Ltd could only proceed with the project, if it proves to be financially viable AND if it is totally financed by share capital, costed based on the estimated cost of a lithium mining company’s share capital, what would be the discount rate you would apply to evaluating the financial viability of the project? (5 marks)
c) Recalculate the NPV, IRR or Profitability Indexof the project using this revised discount rate. Note, you need only recalculate ONE of these measures. (5 marks).
d) Based on this revised project evaluation, if Rural Services Ltd could only proceed with the project, if it proves to be financially viable AND if it is totally financed by share capital costed based on the estimated cost of a lithium mining company’s share capital, would you recommend that the project is financially viable? (5 marks)